Stock-Based Pay, Liquidity, and the Role of Market Making

34 Pages Posted: 25 Sep 2019 Last revised: 11 Aug 2021

See all articles by Riccardo Calcagno

Riccardo Calcagno

Politecnico di Torino

Florian Heider

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Date Written: August 11, 2021

Abstract

We study the role of stock market characteristics on managerial compensation. A risk averse manager exerts an unobservable effort that drives future firm value. The value cannot be used in the incentive contract because it realizes in the distant future and compensating the manager cannot be postponed until then. The stock price emerges endogenously because of trading by informed and uninformed traders in a standard competitive noisy rational expectations equilibrium model. We identify new ''skin-in-the-game'' and ''information-overlap'' terms in the weights the optimal incentive contract gives to the stock price and to public information. We derive novel comparative statics, e.g., the manager may receive more stock-based pay when traders' information becomes worse. The contract always uses public information except in the special case when uninformed traders are risk-neutral.

Keywords: stock-based pay, liquidity, information trading, market making, stock-market efficiency

JEL Classification: G14, G34, D86

Suggested Citation

Calcagno, Riccardo and Heider, Florian, Stock-Based Pay, Liquidity, and the Role of Market Making (August 11, 2021). Journal of Economic Theory, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3459071 or http://dx.doi.org/10.2139/ssrn.3459071

Riccardo Calcagno

Politecnico di Torino ( email )

Corso Duca degli Abruzzi, 24
Torino, Torino 10129
Italy

Florian Heider (Contact Author)

Leibniz Institute for Financial Research SAFE ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany

Goethe University Frankfurt ( email )

Finance Department
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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